The What and Whys of Dollar-Cost Averaging

Last updated on December 4, 2023.

Dollar-cost averaging involves investing a set dollar amount on a regular basis (bi-weekly, monthly or quarterly, for example) regardless of current market prices. Rather than investing a lump sum all at once at one price, dollar-cost averaging is a strategy aimed at reducing risk by taking the guesswork out of timing the market. The idea is that while you will pay more for some of your shares, and less for others, the overall amount per share will average out in the end (and ideally total less than you would have paid had you purchased at one set price).

Like almost everything when it comes to investing, there can be upsides and downsides. Let's explore:

The Advantages of Dollar-Cost Averaging

Lower Average Cost During Market Downturns

Dollar-cost averaging benefits investors when markets prices are dropping because an investor would be able to buy more units or shares with their set dollar amount — so the average cost per unit would be lower.

Market Timing

Trying to time the market, or predicting the best time to get into or out of the market, is extremely difficult (if not impossible!) even for professionals. By having an investment process such as dollar-cost averaging, an investor doesn't have to decide if it's the "right" time to invest because purchases are made throughout various market cycles.

Risk Management

Let's face it, market drops are no fun. Dollar-cost averaging can help risk-averse investors avoid "buyer's remorse" if the market drops sharply since they wouldn't have just invested a big lump sum.

Automatic Investing

Setting up a "mechanical" investment program based on regular savings can help build good financial habits. Once you've chosen your investment amounts, schedule and asset allocation, you can somewhat "set it and forget it."

Confidence

Dollar-cost averaging is an accessible way to get comfortable with investing without making a large financial commitment upfront.

Getting Started

Not everyone has a lump-sum amount to invest. Dollar-cost averaging can let investors start smaller and benefit from market growth over the long-term rather than waiting until they have saved up enough money. (Which could also mean not missing out on any market gains while saving.)

Potential Disadvantages to Consider

Higher Average Cost During Rising Markets

Dollar-cost averaging works both ways depending on the direction of the market. In an upward trending market, your average cost could climb alongside the rising market. In other words, fewer shares or units for your set dollar amount.

Investor Psychology

Dollar-cost averaging may mean you've got extra cash just sitting idle while waiting to be invested. It's good to understand why you've chosen that strategy. Sometimes jumping into the market may be a psychological hurdle. In downward trending markets, there is the fear that markets could continue to drop. And when markets are trending upwards, there can be fear that they're near a top — and as we know, what goes up must come down! In either case, investors can be paralyzed with indecision while cash sits on the sidelines.

In the end, there's no right or wrong when it comes to dollar-cost averaging. It's determining what's right for you.